The general rhetoric in the blockchain and cryptocurrency industry over the last 6 months has focused heavily on Security Tokens, or their offerings, i.e., STOs. 2017 showed how valuable the utility token market could be in the future, and 2018 and 2019 will certainly bring about an entirely new sub-industry of market actors entering the space looking to capitalize on tokenized securities. The Security Token is being hailed for its amalgamation of blockchain technology and traditional financial compliance, but what exactly is it?
I’ve heard some describe it as a utility token with Reg D, S, CF, or A+ compliance. Others describe it as a “asset-backed” token that does not have functionality on a specific platform, but instead is linked to the value of the company itself, paying dividends to those who hold the token. Regardless of the current differences in definitions, and candidly, it seems the industry is trying to rationalize itself around regulatory uncertainty by describing something as a security token. With that said, there are several platforms in development that plan to allow individuals and businesses to develop their own “security” token. Before diving into that, I’ll take a stab at a constructed definition.
What are Security Tokens?
Security tokens are tokens focused on being fully compliant with SEC regulations. In other words, these tokens constitute an investment contract, where the main use-case, and the reason for the purchasers to buy the tokens, is the anticipation of future profits in the form of dividends, revenue share, or (most commonly) price appreciation. This anticipation of profits is one of four factors that the SEC evaluates to determine whether a token is a security. Regulators have stepped up efforts to combat non-compliant tokens and help clarify what constitutes a security, e.g., Operation Cryptosweep.
As stated above, Security Tokens may be able to provide equity, dividends, profit share rights, voting rights, etc., to investors without the regulatory concern associated with utility tokens. Essentially, the tokens, rather than hailed for their functionality, are considered important to provide a right to an underlying asset. These rights are written into a smart contract and the tokens are traded on a blockchain-powered exchange. The key to these tokens are the fact that they are regulatory compliant. In other words, regardless of their function, if a utility token is compliant, it is essentially a security token.
Security Token Offerings:
Advantages of tokenization include fractionalization of larger assets, increased liquidity, lower issuance fees, and greater market efficiency. However, the greatest benefit that security tokens provide an issuer is access to a global pool of capital. As these tokens can be sold and traded internationally (when compliant with regulations), they become more fairly priced and, therefore, attractive to investors. This SEC compliant offering is appealing to both institutional investors for it’s more recognizable structure, and to crypto investors for its technological innovation.
However, the categorization is not that straight forward. Similarly to a Reg D approved utility token, the KYC and AML requirements need to be robust. Businesses should take great care to ensure their token is fully compliant.
Overall, this outgrowth of the traditional token market could substantially disrupt our traditional financial markets because of the capital, liquidity, and security associated with these tokens and platforms the tokens will be traded on. From a regulatory standpoint, the United States will most certainly enforce traditional regulatory procedures, which means accreditation will be required to purchase the tokens, and traditional licensing will be required for traders, brokers, funds, and exchanges. You can think of it as a regulatory compromise to the uncertainty embedded in the currency token marketf.
The following companies are currently building security token platforms.
BCap (Blockchain Capital)